Our Insights

The future of finance in post-Brexit Europe

Expected turbulence ahead as the UK and the EU initiate divorce proceedings

August 11, 2017

In this final installment of the Flight from London series, RBC Investor & Treasury Services assesses the post-Brexit future of Europe's financial services industry.

The withdrawal of the United Kingdom (UK) from the European Union (EU) is set to change the asset management industry.

Key insights

The European Commission is looking to streamline and consolidate the trading of Euro-denominated derivatives within the Eurozone

The UK is aiming to be recognized as an equivalent tax regime under EU law, which would enable London-based firms to retain limited access to European capital markets

While it is unlikely that London, the EU's long-serving financial hub, will be replaced by any single European city, many of London's roles and activities are expected to be recast in the years ahead. As financial services spread across the EU, key hubs such as Dublin, Frankfurt, Paris and Luxembourg each have the opportunity to become more prominent in their areas of expertise.

Asset service providers are already in the process of defining their strategic goals and reassessing their operational requirements as they attempt to prepare for the potential Brexit outcomes. The European Commission has drafted new legislation to govern the trading of derivatives, and the UK is set to pursue recognition as a third-country equivalence regime.

EU to claim Euro-clearing?

Since the UK referendum on EU membership, the European Commission has proposed a series of technical changes to the European Market Infrastructure Regulation (EMIR), which was implemented in 2012. The primary aim of the amendments is to eliminate disproportionate costs and to reduce certain regulatory requirements on specific market participants.1

However, the draft changes also have implications for the ability of UK-based firms to trade European securities.2 If enacted, the new rules would require the clearing of derivatives to be regulated by European authorities, effectively displacing London from trillions of dollars worth of financial transactions.

Stephane Boujnah, CEO of Euronext, has indicated that the change in legislation could result in London-based Euro-denominated trading becoming an anomaly, rather than the standard following Britain's departure from the EU in 2019.3

While financial firms are considering relocating their operations across the continent in a bid to retain access to European markets, London is assessing the options it has to retain its Euro-denominated trading.

Politicians and financial traders have called for greater clarity over the future trading relationship between the EU and the UK

Politicians and financial traders have called for greater clarity over the future trading relationship between the EU and the UK, but few details concerning the terms of post-Brexit trading have emerged. However, the UK government's Brexit white paper indicates that one of its goals for the withdrawal negotiations is to establish the UK as a third-country equivalence regime.4

Third-country option

In 2013, the European Securities and Markets Authority (ESMA) published its technical advice to the European Commission on the equivalence between the third-country (non-EU members) regulatory regime and the EMIR framework.5 Currently, 14 non-EU countries are recognized by ESMA as equivalent regimes,6 enabling firms in countries such as Singapore, Japan and the United States to clear OTC derivatives as if they were operating within the EU.

Establishing the UK as a third-country equivalent regime may ultimately depend on the success of Brexit negotiations

Establishing the UK as a third-country equivalent regime may ultimately depend on the success of Brexit negotiations.7 It remains unclear whether third-country equivalence would satisfy the proposed requirements to EMIR mandating that Euro-denominated clearing be regulated exclusively by European authorities. There is a risk that such an arrangement may erode future investment flows into both UK and EU funds, and some existing investors might consider redeeming their holdings.8

Additionally, UK funds that are currently operating under the UCITS regime would be treated in European Economic Area countries as third country AIFs (as UCITS funds must be EU-domiciled to be marketed to retail clients) on exit from the EU. Thirdcountry AIFs must be marketed in compliance with the national private placement regime within the European Economic Area.9

Brexit volatility

With Brexit approaching, research indicates that global investors may lose their appetite for European investments. According to a survey by EY, 71 percent of investors say their portfolios have been negatively impacted by volatility resulting from the UK's Brexit vote.10 In the same survey, 31 percent of respondents cited the fragmentation of Europe's financial services as a primary cause for concern when deciding on future investment strategies.11

Brexit is not the only underlying cause for concern: the French national election affected investor confidence in Euro-denominated assets, and uncertainty may continue with the upcoming election in Germany. Global investors may shy away from European funds and instead look to capital markets in Asia, North America and the Middle East.12

At the 2017 World Economic Forum in Davos, top banking executives criticized the lack of clear guidelines and implementation strategies for protecting financial interests during Brexit negotiations. Lloyd Blankfein, CEO of Goldman Sachs, advised Prime Minister Theresa May that neither the EU or the UK benefit from the uncertainty.13

A fresh opportunity

Despite the unease that occurred due to potential European instability, there are signs that confidence may be restored. Total assets under management in Europe rose to record highs in 2016, and gains are expected to continue in 2017.14 In addition, the majority of foreign investors indicate they are willing to grow their portfolios in European assets.15

Global investors may be anticipating a bumpy ride as the UK and EU redefine their relationship, but touching down in post-Brexit Europe could prove to be as much an opportunity as it is a challenge. Fund managers who are able to anticipate how the many uncertainties surrounding the UK's departure from the EU will play out could find themselves leading the pack in a new era.

For further post-Brexit insights, refer to RBC Investor & Treasury Services' Flight from London series, which focuses on Dublin, Frankfurt, Luxembourg and Paris.